Recent economic reports have shown that inflation is cooling, even among housing costs, along with expectations that the Federal Reserve is likely finished with raising interest rates.
Headline consumer price index (CPI) increased only by 0.4 percent in April and met expectations, following an energy-constrained 0.1 percent gain in March, Gregory Daco, chief economist at EY, told Observer.
Energy prices rebounded slightly by 0.6 percent while gasoline prices rose, but electricity and utility gas prices fell. Food prices remained the same for the second consecutive month, making the “softest back-to-back readings since mid-2019,” he said.
Core CPI prices, which do not include food and energy costs, appeared “sticky” in April, rising by 0.4 percent month-over-month, but the prices were in line with the average 0.4 percent month-over-month gain over the prior six months, Daco added. It was the smallest increase since September 2021.
But one main culprit has lingered: used car prices surged by 4.4 percent, marking the largest gain since June 2021.
“It’s sticky and bumpy, but make no mistake, inflation is cooling,” he said.
Housing costs only increased by 0.4 percent in April, which was their smallest gain since January 2022. Rent prices rose by 0.6 percent, owners’ equivalent rent increased by 0.5 percent and hotel prices plummeted by 3.4 percent.
“We’re clearly past peak inflation on the housing front, but the slight reacceleration in sequential momentum signals that it will still take a couple more months before we witness a strong and persistent disinflationary trend,” he said. “Still, the slowdown in shelter cost inflation may surprise many on the downside once it gets underway.”
There already is a decline in demand for goods and services, easing housing price inflation and cooling wage growth, which will lead to faster disinflation in the coming months.
“Sequential price momentum points to persistent disinflationary dynamics, but it won’t be a smooth process,” Daco said.
Consumers are seeing a slight reprieve on inflation rates, which impacts their budgets.
Slowing food inflation and normalizing energy prices have “offered consumers some relief from the most painful parts of the price surge seen over the past couple of years,” Sarah House and Michael Pugliese, senior economists at Wells Fargo Economics, wrote in a report. The much-anticipated slowdown in shelter inflation “appears to be drawing nearer, and core services inflation excluding primary shelter showed some tentative signs of easing in April,” they wrote. But don’t expect inflation to fall quickly.
“That said, progress remains incremental rather than rapid,” House and Pugliese wrote. One area of concern is that core CPI inflation reported annualized rates above 5 percent over both the past three months and the past 12 months.
“Even if inflation trends generally seem to be moving in the right direction, we believe it will take significantly more realized progress before policymakers are ready to declare mission accomplished,” they wrote. “Our base case for no additional rate hikes from the FOMC but an extended pause remains intact.”
Fed’s future moves
Core inflation’s annualized pace remains well above the Federal Reserve’s target of 2 percent. The fact that it shows “no signs of trending downward” is critical, said Kurt Rankin, a senior economist at PNC. The Fed’s stance on its current monetary policy will not change until there are “decreases on this front,” he said.
While PNC is not estimating any additional rate hikes in 2023, “tough talk will remain in play from policymakers, Rankin said.
“Those efforts alongside banks’ tightening lending standards could be enough to finally bring an end to inflation into sight,” he said. “Unfortunately, consumer and business activity will also slow in response and PNC’s forecast of a recession beginning in late 2023 still seems likely.”
Inflation will start cooling
As banks tighten credit conditions and approve fewer loans, the situation will “exacerbate the slowdown in employment, business investment and consumer spending activity,” Daco said.
This will lead to a recession with real GDP contracting by 0.2 percent year-over-year during the fourth quarter while headline and core CPI inflation will begin to drop toward 2.7 percent and 3.3 percent year-over-year, respectively, he said.
“If this forecast were to materialize, the Fed could start pivoting toward a recalibration of interest rates later this summer, signaling the possibility of rate cuts in early 2024,” Daco said.